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Optimal Money Burning: Theory and Application to Corporate Dividends

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  • B. Douglas Bernheim
  • Lee S. Redding

Abstract

We explore signaling behavior in settings with a discriminating activity and several costly nondiscriminating (“money‐burning”) activities. Existing theory provides no basis for selecting one method of burning money over another. When senders have better information about activity costs than receivers, each sender's indifference is resolved, the taxation of a money‐burning signal is potentially Pareto‐improving, and the use of the taxed activity becomes more widespread as the tax rate rises. We apply this theory to dividend signaling. Its central testable implication—that an increase in the dividend tax increases the likelihood of dividend payout—is verified empirically.

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  • B. Douglas Bernheim & Lee S. Redding, 2001. "Optimal Money Burning: Theory and Application to Corporate Dividends," Journal of Economics & Management Strategy, Wiley Blackwell, vol. 10(4), pages 463-507, December.
    • Handle: RePEc:bla:jemstr:v:10:y:2001:i:4:p:463-507
    DOI: 10.1111/j.1430-9134.2001.00463.x
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    Cited by:

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    2. Roger Gordon & Martin Dietz, 2006. "Dividends and Taxes," NBER Working Papers 12292, National Bureau of Economic Research, Inc.
    3. Raj Chetty & Emmanuel Saez, 2007. "An Agency Theory of Dividend Taxation," NBER Working Papers 13538, National Bureau of Economic Research, Inc.
    4. Correia-da-Silva João & Pinho Joana & Vasconcelos Hélder, 2015. "How Should Cartels React to Entry Triggered by Demand Growth?," The B.E. Journal of Economic Analysis & Policy, De Gruyter, vol. 15(1), pages 1-47, January.
    5. Araujo, Aloisio & Moreira, Humberto & Tsuchida, Marcos, 2011. "Do dividend changes signal future earnings?," Journal of Financial Intermediation, Elsevier, vol. 20(1), pages 117-134, January.
    6. Dino Falaschetti & Michael Orlando, 2003. "Cutting the Dividends Tax…and Corporate Governance Too?," Finance 0311008, University Library of Munich, Germany.
    7. Erin E. Syron Ferris, 2018. "Dividend taxes and stock volatility," International Tax and Public Finance, Springer;International Institute of Public Finance, vol. 25(2), pages 377-403, April.
    8. Himmelberg, Charles P. & Tsyplakov, Sergey, 2020. "Optimal terms of contingent capital, incentive effects, and capital structure dynamics," Journal of Corporate Finance, Elsevier, vol. 64(C).
    9. Bechman, Ken L. & Raaballe, Johannes, 2006. "Taxable Cash Dividends," Working Papers 2005-4, Copenhagen Business School, Department of Finance.
    10. Randall Morck & Bernard Yeung, 2005. "Dividend Taxation and Corporate Governance," Journal of Economic Perspectives, American Economic Association, vol. 19(3), pages 163-180, Summer.
    11. Greco, Luciano G., 2006. "The optimal design of funded pensions," LSE Research Online Documents on Economics 24519, London School of Economics and Political Science, LSE Library.

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